If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. So when we looked at AppFolio (NASDAQ:APPF) and its trend of ROCE, we really liked what we saw.
Return On Capital Employed (ROCE): What is it?
Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. The formula for this calculation on AppFolio is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.017 = US$5.6m ÷ (US$379m - US$43m) (Based on the trailing twelve months to March 2021).
So, AppFolio has an ROCE of 1.7%. In absolute terms, that's a low return and it also under-performs the Software industry average of 11%.
Above you can see how the current ROCE for AppFolio compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering AppFolio here for free.
What The Trend Of ROCE Can Tell Us
AppFolio has recently broken into profitability so their prior investments seem to be paying off. The company was generating losses five years ago, but now it's earning 1.7% which is a sight for sore eyes. In addition to that, AppFolio is employing 368% more capital than previously which is expected of a company that's trying to break into profitability. We like this trend, because it tells us the company has profitable reinvestment opportunities available to it, and if it continues going forward that can lead to a multi-bagger performance.
The Bottom Line
To the delight of most shareholders, AppFolio has now broken into profitability. And with the stock having performed exceptionally well over the last five years, these patterns are being accounted for by investors. With that being said, we still think the promising fundamentals mean the company deserves some further due diligence.
One final note, you should learn about the 3 warning signs we've spotted with AppFolio (including 2 which don't sit too well with us) .
While AppFolio isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.
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